Tuesday, January 18, 2005

Financial notes from Ukraine

This is one of the first financial reports on Ukraine since the November events. It is also one of the few reports that are not part of the marketing of Ukrainian securities.
FOREIGNERS BULLISH ON YUSHCHENKO'S UKRAINE
Since the election of Yushchenko investors have begun flocking to Kiev.

By Peter Graff, Reuters, Kiev, Ukraine, Tue, January 18, 2005

KIEV -- If investors hadn't heard of Ukraine a few months ago, they have
now. A country of nearly 50 million people, Ukraine has a four-year track
record of booming, export-driven economic growth and a fat trade surplus.
Last week it announced record gross domestic product growth last year of 12
percent, Europe's best.

But fundamentals aside, two political factors have finally put Ukraine
squarely on the map since the middle of last year. It suddenly acquired a
long frontier with the European Union when the bloc expanded in May. And it
now has a new pro-Western president after public protests helped overturn an
election result in November that had been rigged to favor a pro-Moscow
candidate.

Liberal President-elect Viktor Yushchenko, who won a rerun vote last month,
campaigned on a platform of transparency, fighting corruption and opening
investment opportunities to outsiders. He had a strong record of reform when
he served as Central Bank chief and prime minister several years ago.

Bond traders on emerging markets desks abroad have known about Ukraine for
some time. Its debt, traded in London and New York, has performed well for
several years. "It had a very strong financing position, current account
surplus, rising reserves, good growth, and it had been a regular issuer in
the market, which raised the country's profile," said Timothy Ash, head of
emerging markets at Bear Stearns in London.

But more investors are now flying in to Kiev and looking at local
investments like stocks and domestic bonds. Tomas Fiala, a Czech who runs
Dragon Capital, one of Ukraine's few brokers, said calls from fund managers
started flooding in just before Yushchenko's "orange revolution." "Since
September we have had at least one European or U.S. investor around here
every week. Some weeks it was at least three investors coming for investment
trips," he said.

Not only are more fund managers coming, they are coming from a different
direction -- east from over the borders of new EU members like Poland or
Hungary, rather than west from Moscow. "We're getting a lot of calls from
Central Europe and a lot of Austrian, German, French and U.K. investors,"
Fiala said. "The election ... changes Ukraine's future development from
tracking Russia to trying to move into Europe and follow Poland, the Czech
Republic, Hungary and Slovakia," Fiala said.

The short-term economic picture is not all rosy. Inflation picked up sharply
because of a pre-election spending binge by the outgoing authorities, who
sold off reserves and handed out higher pensions and wages. Price growth hit
12.3 percent last year, the government said this week, a four-year high up
from 8.2 percent in 2003.

Ukraine's economy is still dominated by former-Soviet heavy industries,
especially steel and chemicals. Those industries have boomed over the past
few years driven by strong demand for industrial raw materials in developing
Asia. But those markets are cyclical and possibly in for a rough patch.

For most investors the only chance of exposure to Ukraine has been debt
issued abroad. The government and private companies both had successful
eurobond placements over the past year. Firm demand has brought yields on
dollar-denominated sovereign debt as low as around 7.3 percent.

"It's been on the radar screens for a long time from a fixed-income
perspective. Equities less so," said Ash. "Obviously there's a lot of issues
about corporate governance. That certainly restricted interest. Going
forward, the interest will be more focused on the equity."
Those flocking to Kiev will not yet find much to buy.

Ukraine's stock market was the world's fastest-rising last year, with an
index compiled by Dragon Capital surging by 180 percent. But volume
is tiny and there are only about 30 traded companies, and only 10 liquid
enough to make the index.

Yushchenko has promised to increase privatizations open to foreigners, which
should make for a more robust market. Domestic government debt may also
still be a good buy, with double-digit yields denominated in a hryvnia
currency that has been stable for years and -- given the large trade
surplus -- could appreciate against a falling dollar.

Foreign investors have doubled their holdings in Ukraine's domestic debt in
the last six months, the Finance Ministry says. Foreigners bought 80 percent
of the paper at an auction last week, the first since the rerun election.
But the best long-term opportunities may be for strategic investors in
sectors like brewing, food processing, retail or construction, aimed at the
still-stunted domestic market.

Ukraine's economy is now 60 percent exports, with local consumption held
back by monthly average incomes of barely $100. If Ukrainians' living
standards ever start approaching those of their new EU-member neighbors,

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